One step forward, two steps backwards

SEBI’s decision to keep the equity derivative market open for almost 15 hours will take a toll on traders and other stakeholders. Higher volatility will enhance the mindset of excessive speculation, and the resultant greed in the society. The regulator should have looked at such concerns, and followed the US system of dividing the timings into three parts – pre-market, regular market, and after-market

A few weeks ago, the Securities and Exchange Board of India (SEBI) issued a circular in which it mentioned that, over a period of time, the derivative segment of the Indian stock market would be required to do physical settlement. This means that the volumes in the derivative segment would come down. Also, the SEBI asked the exchanges to increase the margins, which are paid by traders to exchange, before they can take exposure to any derivative trade, so that excessive speculation by paying a small amount of margin money is curbed.

To make a further dent on speculative activity in the markets, the SEBI asked brokers to collect income tax returns (ITR) of investors who trade in derivative market so that it can judge whether an individual trader has the financial strength to deal with derivative instruments or not. This is being done so that there is some relationship between the income and exposure, which a trader undertakes in derivative instruments. All these steps were undertaken with the intention of reducing speculative volumes on Indian bourses.

In real life, traders would be tempted to take positions around the time when the US market is about to open and also around midnight

The market regulator allowed the exchanges to extend the trading window in the derivative segment from 9 AM to 11.55 PM from the current time limit of 9 AM to 3.30 PM. The extension of the trading window, however, appears to be at cross purposes with the steps taken by the SEBI to curb speculative trading, On one hand, every effort is being made to ensure that only those who have the ability to take risks should enter the derivative segment, on the other, the time limit for derivative markets is being extended. This extension of the time window means doubling the derivative market duration from the current seven and a half hours to 14 hours and fifty-five minutes. If the market remains open for a longer duration, speculative volumes in the derivative segment are bound to increase and not going to come down.

In real life, traders would be tempted to take positions around the time when the US market is about to open and also around midnight when trading would be coming to close in India. Now, most of the times, those positions would be taken for the next day’s trade, but even after extended timings, the Indian market would be closing for trading one and a half hour before the US market finishes its business for the day. Many times in the past, the colour of the US market changed from green to red or red to green in the last one and a half hour of trading.

IN that case, what happens to all the trade that is taken under the impression that what is happening in the US market at night would be repeated in the Asian and Indian markets next morning? What if the trend in the US market is not repeated in the Indian market? It’s happening regularly these days. It would lead to a situation where volatility in the Indian market would increase sharply when the market opens for trading the next morning. So, extension in timing means speculative volumes and also an increase in volatility.

Why introduce another element that might lead to greater volatility in the markets, especially when it is known that lower volatility is better

Why introduce another element that might lead to greater volatility in the markets, especially when it is known that lower volatility is better for every stakeholder in the capital market. Markets which are less volatile tend to get higher valuations. In fact, exchange trade funds which follow the Nifty or Sensex as their benchmark, this volatility would hurt them a lot. Our policy makers should not forget that a large part of domestic money, which is coming into market is coming to index funds, and if the index becomes volatile, flow to these funds would come down, which in the long term will have a negative impact not only on the Indian capital market, but also the economy as well.

The argument that Indian investors and traders would be in position to react to any major global development when the US markets open for trade is a flawed one. Yes, it would help foreign investors, who would be able to trade in Indian indices as per their own convenience, instead of placing overnight orders to their Hong Kong or local desks in India. Also, it will probably help some large brokerages, who in any case, keep a part of their offices open till midnight for commodity traders. Surely, stock exchanges will earn more money with the increase in volumes as their collections from transaction fee will increase. But, would it bring anything to the table for the investors? The answer is no. Stock markets are primarily for investors and not for traders.